Moody's Investors Service has said that the federal budget sequestration's planned reduction of interest rate subsidies on Build America Bonds is a credit negative for municipal issuers.

U.S. municipalities and states issued approximately $200 billion of BABs in 2009 and 2010.

On September 14 the White House Office of Management and Budget announced that as part of the sequestration, $322 million or 7.6% of the payments to subsidize interest payments would be cut in fiscal 2013. The cuts would commence at the start of calendar year 2013. The cuts would come under the legally mandated process, sequestration, by which $1.2 trillion would be cut from federal programs across the board because Congress failed to reduce the federal deficit last year.

Cutting BAB subsidies would reduce income for BAB issuers, Moody's stated. "However, the effect on the ability to pay debt service is mitigated to the extent that most general obligation bond issuers budget to pay full debt service without accounting for receipt of the interest subsidies and most revenue bond issuers did not pledge the subsidies to bond holders," Moody's senior credit officer Nick Samuels wrote. "Instead they use the subsidy to offset debt service costs once the subsidy is received." Moody's expects these issuers to experience a minimal amount of strain if the federal subsidy is cut.

"Some issuers, however, rely on timely receipt of the federal interest subsidy to complement another revenue source in order to make debt service payments. These issuers may need to make budget adjustments or draw on a debt service reserve (if one was established) to mitigate a reduced federal subsidy. Some issuers included extraordinary mandatory redemption provisions in their BAB issuances, triggered by reductions in federal subsidy amounts, which they may now have to consider."

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